Q1 2024 showcased global market resilience and adaptability amid significant challenges. Strategic monetary policies in the U.S. and Canada, alongside economic reforms in Asia, have set the stage for sustained growth, with a cautiously optimistic outlook supported by strong asset performances.
Market Review
U.S. Market Overview
Despite a global environment fraught with geopolitical tensions and internal political uncertainties, U.S. markets kicked off the year on a strong note. Investors were greeted by resilient corporate profits, renewed vigour in the initial public offering market, and a heightened enthusiasm for emerging technologies, particularly artificial intelligence. These factors propelled the S&P 500 to multiple new all-time highs, with the index registering record closes on nearly 40% of the trading days this quarter. This period also witnessed the longest-ever inversion of the yield curve, a phenomenon reflecting underlying economic stress points. In light of stubbornly robust inflation data and a highly resilient U.S. economy that has continued to expand, the Federal Reserve moved toward a more cautious stance on monetary easing, projecting at most three rate cuts in 2024 versus six cuts toward the end of last year. This cautious optimism regarding macro fundamentals pervaded the market, dispelling recession fears and fueling a significant rally in both large and small-cap stocks, with large caps particularly benefitting from robust performances across the technology sector.
Canada: A Parallel Narrative
In Canada, the first quarter mirrored the positive trends observed in the U.S., with investors experiencing substantial returns amidst a challenging global landscape. Like its southern neighbour, Canada’s economic backdrop—a mix of strong consumer spending, a recovering housing market and stable industrial activity—supported the financial markets. Both the Bank of Canada and the U.S. Federal Reserve are treading carefully on the path to interest rate reductions, reflecting a strategic response to the moderate inflation and strong economic resilience. This cautious monetary policy fostered confidence in equity and risk asset markets, particularly benefiting sectors tethered to economic expansion. Additionally, Canadian small caps, which had previously lagged, saw a reversal of fortunes, showcasing strong outperformance attributed to attractive valuation levels and a conducive economic environment that enhances prospects for mergers and acquisitions.
Asia-Pacific Dynamics
The quarter in the Asia-Pacific region was marked by volatility but ended with positive gains. The Asia Pacific Japan markets, after a rocky start, rallied significantly, closing with modest overall gains. This recovery was spearheaded by record highs in several key markets, including Japan, Australia, India, Indonesia and Taiwan, fueled by advancements in technology and commodities. The region’s economic dynamics were heavily influenced by shifts in the U.S. dollar, impacting export-driven economies and investor sentiment. Noteworthy were the corporate governance improvements in Japan and the anticipated regulatory reforms in Korea aimed at enhancing corporate transparency and investor relations. Meanwhile, China showed signs of stabilization with regulatory adjustments and vigorous consumer spending during key holiday periods indicating a potential turnaround in market sentiment. Positive diplomatic and corporate developments also suggested an improving business climate aimed at attracting foreign investment, particularly from the U.S., setting a favourable stage for future economic interactions.
Key Q1 2024 Takeaways
The first quarter of 2024 highlighted the resilience and adaptability of global markets amidst significant geopolitical and economic challenges. The deliberate monetary policies in the U.S. and Canada, combined with strategic economic reforms and improvements in corporate governance in Asia, have primed the global markets for sustained growth. With investors showing a robust appetite for risk, as demonstrated by strong performances in diverse asset classes, the outlook for the coming quarters remains cautiously optimistic, suggesting a stable trajectory for global economic activity and market performances.
Quarterly results by strategy
Canadian Small Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom Canadian Small Cap Composite, compared to the S&P/TSX Canadian Small Cap Index and the S&P/TSX Composite Index (as at March 31, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
*Note: Results are the BMO Small Cap Blended Weighted Index from June 30, 1992 to December 31, 1999 and thereafter the S&P/TSX Canadian Small Cap Index.
** Note : June 30, 1992
Portfolio Positioning
In the first quarter of 2024, our Canadian Small Cap Strategy not only showcased robust performance, but it also outperformed the TSX Small Cap Index. This success underscores the efficacy of Van Berkom’s investment philosophy and process, reflecting the skills of our investment team in identifying outstanding small-cap companies. The strong results in the first quarter were largely due to our meticulous security selection, which alone contributed over 5% to our relative outperformance. We focus on a carefully curated portfolio of high-quality companies that demonstrate promising organic and inorganic growth, potential for multiple expansion, and are trading at attractive valuations. Our approach consistently seeks to uncover companies with robust growth prospects rather than merely following market trends.
Notably, our relative success occurred despite significant challenges from sectors where we have little to no exposure. For example, the market’s infatuation with artificial intelligence (AI) and related technologies led to inflated valuations and speculative investments reminiscent of the early days of the internet. However, our disciplined investment strategy allowed us to remain focused on fundamental value rather than speculative growth. Furthermore, the introduction of bitcoin exchange-traded funds in January fuelled a rally in cryptocurrencies, with bitcoin appreciating about 60% year-to-date. This trend presented another headwind to our strategy, as the market fervour for blockchain and digital assets diverged from our investment criteria focused on sustainable earnings growth and solid fundamentals.
Despite facing a market environment swayed by AI enthusiasm and cryptocurrency trends, our portfolio remains well-positioned.
Significant contributors to performance include the following stocks:
- MDA (+27.7%) due to strong Q4 and FY 2023 results, with significant guidance predicting over 20% revenue growth for 2024-2025.
- Aritzia (+36.0%), rebounding from previous margin pressures, with profitability normalization expected to significantly increase in FY 2025.
- Topicus.com (+38.7%), benefiting from robust organic and acquisition-driven growth.
- Mainstreet Equity (+28.7%), driven by strong immigration and higher rents in Western Canada.
- Ag Growth International (+21.8%), supported by solid financials and strategic manufacturing efficiencies.
- Tucows (-30.3%), due to rising interest rates impacting its capital-intensive Ting Internet business despite stable operations in other divisions.
- ATS Automation (-20.2%) as slowing EV orders and project delays dampened investor sentiment despite strong quarterly growth.
- Enghouse Systems (-12.5%), with margins pressured by recent acquisitions and contract integrations.
- Jamieson Wellness (-15.5%) amid increased investment in China impacting profitability.
- Richelieu Hardware (-10.9%), hurt by pricing deflation and inventory cost lags despite a strong macroeconomic outlook.
Portfolio Changes
We’ve strategically refined our model portfolio this quarter to bolster long-term alpha by making several key adjustments:
Increased Holdings: We enhanced our positions in Enghouse Systems, ATS Corp., Badger Infrastructure Solutions, Computer Modelling Group and MDA Corp., capitalizing on their growth potential not currently reflected in their market valuations.
Reduced Holdings: We scaled back shares in Lumine Group, Adentra, Trisura Group and Pet Valu Holdings, managing valuation and portfolio weight concerns.
New Additions:
- Cineplex Inc.: Initiated due to its dominant Canadian market share and potential uplift from increased movie supply and diversified revenue streams.
- Wajax Corp.: Added for its robust industrial parts service and improved relations with Hitachi, anticipated to drive shareholder value.
- Boyd Group Services Inc.: Included for its strong position in the consolidating collision repair industry and expected high returns on capital from acquisitions.
- Richard’s Packaging Income Fund: Selected for its high ROE and growth in the healthcare segment, combined with low capital expenditure requirements.
- Hamilton Thorne Ltd.: Chosen for its leadership in the growing IVF market and ongoing strategic acquisitions enhancing its global footprint.
Divestitures:
- Spin Master, Leon’s Furniture and Logistec Corp.: Exited these positions, reallocating capital to more promising small-cap opportunities.
Outlook
The global and Canadian economies have manoeuvred through significant challenges, including a pronounced tightening cycle by central banks aimed at curbing persistent inflation. While uncertainties persist, the avoidance of a severe hard-landing scenario is likely, and the ongoing economic expansion appears sustainable. Central banks have signalled a readiness to ease the pressure on consumers and businesses, which bodes well for continued economic growth and supportive conditions for rising corporate earnings.
The current economic environment presents a mix of solid fundamentals and unresolved complexities within this unique cycle. It remains uncertain whether the existing economic activity and corporate earnings are sufficient to drive significant stock market gains, particularly given the robust stock valuations observed recently. In this evolving market landscape, we foresee a shift toward a less thematic, more discriminating investment approach focused on company-specific fundamentals and tangible financial performance. Such a trend could serve as a favourable wind for our investment strategy, emphasizing discernment in stock selection.
As we move into Q2, our strategy remains unchanged, leveraging a high-quality model portfolio that has consistently delivered strong returns. Looking ahead, the backdrop for our investment decisions remains cautiously optimistic. We expect the broader market to reward discerning investments that are backed by solid fundamentals rather than speculative momentum. This environment should favour our strategy of focusing on value, quality, and potential for growth, aligning with our long-standing commitment to deliver superior returns.
Overall, the outlook for Q2 and beyond is shaped by a complex yet promising set of economic conditions. Our continued focus on rigorous fundamental analysis and strategic portfolio management positions us well to navigate these challenges and capitalize on the opportunities they present, ensuring sustained outperformance and value creation for our clients.
Reduced Holdings: We scaled back shares in Lumine Group, Adentra, Trisura Group and Pet Valu Holdings, managing valuation and portfolio weight concerns.
New Additions:
- Cineplex Inc.: Initiated due to its dominant Canadian market share and potential uplift from increased movie supply and diversified revenue streams.
- Wajax Corp.: Added for its robust industrial parts service and improved relations with Hitachi, anticipated to drive shareholder value.
- Boyd Group Services Inc.: Included for its strong position in the consolidating collision repair industry and expected high returns on capital from acquisitions.
- Richard’s Packaging Income Fund: Selected for its high ROE and growth in the healthcare segment, combined with low capital expenditure requirements.
- Hamilton Thorne Ltd.: Chosen for its leadership in the growing IVF market and ongoing strategic acquisitions enhancing its global footprint.
Divestitures:
- Spin Master, Leon’s Furniture and Logistec Corp.: Exited these positions, reallocating capital to more promising small-cap opportunities.
Outlook
The global and Canadian economies have manoeuvred through significant challenges, including a pronounced tightening cycle by central banks aimed at curbing persistent inflation. While uncertainties persist, the avoidance of a severe hard-landing scenario is likely, and the ongoing economic expansion appears sustainable. Central banks have signalled a readiness to ease the pressure on consumers and businesses, which bodes well for continued economic growth and supportive conditions for rising corporate earnings.
The current economic environment presents a mix of solid fundamentals and unresolved complexities within this unique cycle. It remains uncertain whether the existing economic activity and corporate earnings are sufficient to drive significant stock market gains, particularly given the robust stock valuations observed recently. In this evolving market landscape, we foresee a shift toward a less thematic, more discriminating investment approach focused on company-specific fundamentals and tangible financial performance. Such a trend could serve as a favourable wind for our investment strategy, emphasizing discernment in stock selection.
As we move into Q2, our strategy remains unchanged, leveraging a high-quality model portfolio that has consistently delivered strong returns. Looking ahead, the backdrop for our investment decisions remains cautiously optimistic. We expect the broader market to reward discerning investments that are backed by solid fundamentals rather than speculative momentum. This environment should favour our strategy of focusing on value, quality, and potential for growth, aligning with our long-standing commitment to deliver superior returns.
Overall, the outlook for Q2 and beyond is shaped by a complex yet promising set of economic conditions. Our continued focus on rigorous fundamental analysis and strategic portfolio management positions us well to navigate these challenges and capitalize on the opportunities they present, ensuring sustained outperformance and value creation for our clients.
U.S. Small Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom U.S. Small Cap Composite (in U.S. dollars), compared to the Russell 2000 Small Cap Index and the S&P 500 Index (as at March 31, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : June 30, 2000
Portfolio Positioning
The first quarter of 2024 presented unique challenges for our U.S. small-cap strategy, resulting in underperformance relative to the Russell 2000 small-cap benchmark in a robust market environment. This quarter’s market dynamics were largely thematic, influenced heavily by investor enthusiasm for artificial intelligence and cryptocurrency-related stocks. Notably, stocks like Super Micro Computer and MicroStrategy soared, disproportionately impacting the Russell 2000’s performance due to their large market capitalizations and relevance to these themes. Together, these stocks accounted for a significant portion of the Russell 2000’s total quarterly returns.
Additionally, the quarter saw unusual movements in the biotech sector and significant interest in IPOs of companies like Reddit and Trump Media and Technology Group. These developments underpinned a market atmosphere that favoured speculative investments over solid, fundamental growth, posing challenges to our investment strategy focused on high-quality criteria.
Despite the thematic nature of the market impacting the relative performance of our Information Technology holdings adversely, our portfolio maintained healthy security selection in core sectors like Consumer Discretionary, Financials, Industrials and Healthcare. However, the exceptional performance of specific technology stocks within the Russell 2000 overshadowed our gains in these areas.
In terms of asset allocation, our lack of exposure to the surging Energy sector and an overweight position in the lagging Financials sector impacted our performance negatively. Conversely, avoiding the underperforming Real Estate sector and a higher allocation to the robust Information Technology sector helped largely mitigate these headwinds.
As we move forward, we will continue to adapt our strategy to align with market conditions while maintaining a focus on disciplined stock selection and portfolio management to navigate the ongoing complexities of the current investment landscape.
Significant contributors to performance in Q1 2024:
- Shake Shack (+42%), driven by strong financials and expanded market share.
- Installed Building Products (+42%) and Armstrong World Industries (+26%), due to favourable market conditions and solid management, both benefiting from industry rebounds and strategic execution.
- Primoris Services (+28%), due to sustained strong financial results, confirming a very successful pivot toward large solar plants and other types of renewable energy projects.
- Victory Capital (+24%) and Envestnet (+16%), leveraging their business models to capitalize on growing investor risk appetite and strong markets.
Stocks that detracted from our portfolio’s performance in Q1 2024:
- Iridium Communications (-36%), due to disappointing 2024 revenue growth projections and competition from Starlink.
- Yeti Holdings (-24%), after issuing a slightly weak financial forecast influenced by reduced consumer spending on discretionary products.
- Fox Factory (-23%), reflecting struggles in its core markets and poor communication.
Portfolio Changes
During the March quarter, we strategically adjusted our portfolio to optimize performance and respond to market conditions:
Added Five9 Inc.: We integrated Five9 into our portfolio due to its leadership in the contact center as a service (CCaaS) industry. With a solid track record of revenue growth and high retention rates, Five9 represents a growth opportunity as the CCaaS market continues to expand. The company’s strong competitive position and innovative technology offerings, particularly in AI, make it a strategic addition.
Completed Position in Planet Fitness: We capitalized on market weaknesses to fully integrate Planet Fitness into our holdings. Despite short-term controversies and market noise, the company’s long-term growth prospects remain strong, supported by its consistent unit growth and effective pricing strategies.
Rebalanced Holdings: We adjusted the weights of several stocks to align with strategic goals:
- With Iridium Communications, Yeti Holdings, DoubleVerify, Ormat Technologies, Grand Canyon Education, Bank OZK and StoneX Group, we increased stakes following a pullback, recognizing their potential for long-term value.
- With Shake Shack, Installed Building Products, Armstrong World Industries, Envestnet, Houlihan Lokey, DigitalOcean, Tempur Sealy International, Ensign Group and Primoris Services, we realized profits due to expanded valuation multiples, trimming positions while maintaining exposure to these high-quality investments.
These changes reflect our proactive approach to portfolio management, aiming to leverage emerging opportunities and adjust exposures based on evolving market dynamics and company fundamentals.
Outlook
Despite significant challenges including a tightening cycle by the Federal Reserve and persistent inflation, the U.S. economy appears to have sidestepped a severe hard-landing scenario. Looking ahead, the Federal Reserve’s commitment to providing economic relief suggests continued growth and support for rising corporate earnings, which are crucial for sustaining the stock market rally. However, with U.S. stock valuations currently high and investor sentiment optimistic, the expectations for corporate earnings are elevated as we enter the upcoming earnings season.
The forthcoming U.S. Presidential election may introduce further volatility, yet historically, such periods have been associated with positive market performance. Nevertheless, the current economic cycle presents unique challenges, and it remains uncertain whether the economic activity and corporate earnings will be robust enough to drive significant market gains, especially given the healthy valuations of most stocks.
Our outlook suggests a shift toward a market that values individual stock fundamentals over thematic trends. We anticipate less correlation among stocks, with a greater focus on specific company performances. Our portfolio is well-positioned in this context, trading at a 7% discount to its intrinsic value with promising financial indicators. We expect 12%-15% earnings growth this year and a 13% annual EPS growth over the next five years, supported by strong returns on equity and investment and minimal debt levels. Compared to the Russell 2000 small-cap index, our portfolio exhibits cleaner balance sheets, higher profit margins, and significantly stronger returns on equity and investment. Notably, our financial metrics and portfolio fundamentals are also competitive with those of the S&P 500 large-cap index, positioning us favourably within the small-cap sector.
The solid fundamentals and superior quality of our portfolio provide a strong foundation for potential outperformance in the upcoming quarters. As we navigate this uncertain macroeconomic environment, our strategic positioning and rigorous analysis reinforce our confidence in achieving sustained success and delivering value to our investors.
Completed Position in Planet Fitness: We capitalized on market weaknesses to fully integrate Planet Fitness into our holdings. Despite short-term controversies and market noise, the company’s long-term growth prospects remain strong, supported by its consistent unit growth and effective pricing strategies.
Rebalanced Holdings: We adjusted the weights of several stocks to align with strategic goals:
- With Iridium Communications, Yeti Holdings, DoubleVerify, Ormat Technologies, Grand Canyon Education, Bank OZK and StoneX Group, we increased stakes following a pullback, recognizing their potential for long-term value.
- With Shake Shack, Installed Building Products, Armstrong World Industries, Envestnet, Houlihan Lokey, DigitalOcean, Tempur Sealy International, Ensign Group and Primoris Services, we realized profits due to expanded valuation multiples, trimming positions while maintaining exposure to these high-quality investments.
These changes reflect our proactive approach to portfolio management, aiming to leverage emerging opportunities and adjust exposures based on evolving market dynamics and company fundamentals.
Outlook
Despite significant challenges including a tightening cycle by the Federal Reserve and persistent inflation, the U.S. economy appears to have sidestepped a severe hard-landing scenario. Looking ahead, the Federal Reserve’s commitment to providing economic relief suggests continued growth and support for rising corporate earnings, which are crucial for sustaining the stock market rally. However, with U.S. stock valuations currently high and investor sentiment optimistic, the expectations for corporate earnings are elevated as we enter the upcoming earnings season.
The forthcoming U.S. Presidential election may introduce further volatility, yet historically, such periods have been associated with positive market performance. Nevertheless, the current economic cycle presents unique challenges, and it remains uncertain whether the economic activity and corporate earnings will be robust enough to drive significant market gains, especially given the healthy valuations of most stocks.
Our outlook suggests a shift toward a market that values individual stock fundamentals over thematic trends. We anticipate less correlation among stocks, with a greater focus on specific company performances. Our portfolio is well-positioned in this context, trading at a 7% discount to its intrinsic value with promising financial indicators. We expect 12%-15% earnings growth this year and a 13% annual EPS growth over the next five years, supported by strong returns on equity and investment and minimal debt levels. Compared to the Russell 2000 small-cap index, our portfolio exhibits cleaner balance sheets, higher profit margins, and significantly stronger returns on equity and investment. Notably, our financial metrics and portfolio fundamentals are also competitive with those of the S&P 500 large-cap index, positioning us favourably within the small-cap sector.
The solid fundamentals and superior quality of our portfolio provide a strong foundation for potential outperformance in the upcoming quarters. As we navigate this uncertain macroeconomic environment, our strategic positioning and rigorous analysis reinforce our confidence in achieving sustained success and delivering value to our investors.
Greater China Growth Strategy
Investment Performance
The following table shows the investment performance results of the Van Berkom Golden Dragon Greater China Growth Composite (in U.S. dollars), compared to the MSCI China and the MSCI Golden Dragon Small Cap Indices (as at March 31, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : December 31, 2011
Portfolio Positioning
Our portfolio saw moderate activity this quarter, with significant focus on our Taiwanese positions which benefited from advancements in AI and a resurgence in the semiconductor cycle. These positions have been instrumental in driving up margins, thanks to robust demand from tech giants like Microsoft and Google for memory and processing power critical for AI developments.
In the semiconductor space, our investments in major Korean memory producers paid off, with memory prices surging over 60% due to unexpected high capital expenditures from leading technology firms. This trend underscores the structural growth potential in AI and technology, validating our continued investment in Asian companies leading in these sectors. Noteworthy is the performance of Chicony Power and Chicony Electronics, with returns of 12% and 20% respectively for the quarter. These companies have capitalized on the increased power requirements of devices, driving up Average Selling Prices (ASPs) by delivering higher wattage power adapters and AI-adaptive peripherals.
Our long-term strategy benefits from a global perspective, refined by over a decade of investing in Asia, allowing us to identify and leverage key players in the tech supply chain. This strategy was evident in our recent exploratory trips to Japan and Korea, where we uncovered promising companies with significant roles in AI and tech, yet trading at substantial discounts compared to their U.S. counterparts like Nvidia.
Additionally, the portfolio saw heightened activity in share buybacks, continuing the trend from 2023. Notable was the significant personal investment in Alibaba shares by co-founders Jack Ma and Joseph Tsai, highlighting market undervaluation and leading to five potential privatizations within our portfolio. Companies like L’Occitane and Samsonite are exploring strategic options including talks with private equity firms and possible secondary listings to enhance liquidity and valuation.
In the real estate sector, our focus has shifted towards more financially stable SOE property companies in China. Despite the broader market challenges, our investments in Yuexiu Services and Coli Property have shown robust growth and strong financial health, validating our strategic reallocation from more volatile holdings like Country Garden Services, whose parent company’s struggles have overshadowed its operational success.
Our top five contributors to portfolio performance in Q1 2024: Trip.com (+24%), L’Occitane (+42%), Techtronic (+14%), Samsonite (+15%) and New Oriental (+23%).
Our top five detractors from portfolio performance in Q1 2024 : Weimob (-34%), Country Garden Services (-26%), China Overseas Property (-26%), JD Health (-29%) and Ifast (-21%).
Overall, the quarter was marked by strategic adjustments to harness growth opportunities in high-tech and real estate, while maintaining a cautious approach to market uncertainties and sector-specific challenges. This careful curation of our portfolio positions us favourably for potential market shifts and ensures sustained growth and stability.
Portfolio Changes
In response to market volatility, particularly in China, our portfolio has undergone strategic adjustments to enhance value and position for future growth:
- Exited Positions: We fully exited SGX due to its lower growth prospects relative to our portfolio. Also exited Bilibili and Xinyi Energy, with Bilibili facing structural challenges from the rising popularity of shorter video formats, and Xinyi Energy experiencing a slowdown in its energy storage business.
- Rotated Positions: We shifted investments from Tongcheng Elong to other travel stocks due to concerns over cash flow and opaque acquisition strategies.
- New Addition – ESR Group: We initiated a position in ESR Group, a leader in APAC real estate investment with a significant assets under management (AUM). ESR offers robust investment opportunities across diverse real estate sectors, leveraging a well-established fund management business and a strategic focus on new economy assets like logistics and data centres. This addition aligns with our strategy to capitalize on structural economic shifts in APAC.
- Investment Strategy: We maintained focus on sectors less impacted by current market challenges, particularly those not directly affected by broader economic pressures in China. We anticipate these sectors, especially logistics and green energy buildings, to benefit significantly from ongoing e-commerce growth and increased environmental consciousness.
- Forward-Looking Strategy: We aim to expand ESR’s AUM, especially in sectors driven by enduring trends such as e-commerce and sustainability, expecting significant asset sales and value realization in the latter half of 2024.
Outlook
Emerging markets (EM) continue to represent a significant mispricing opportunity amidst global uncertainties, including geopolitical tensions and a prevailing preference for USD assets and large-cap stocks. Notably, the so-called magnificent seven, which derive over half their revenue internationally, underscore the global nature of these investments. The valuation gap between emerging and developed markets (DM) is striking, with EM trading at a price-to-earnings (P/E) ratio of 12x, contrasted with 18.9x for DM and 21.7x for the US. Despite the challenges, particularly in China, overlooking the potential in Asia means missing out on compelling, structural growth stories likely to yield considerable returns. The current outflows from EM, driven by skeptical investors, present a unique entry point. Election outcomes may initially increase market volatility, but leadership clarity could stimulate significant capital inflows, enhancing returns across these markets.
The possibility of increased tariffs under potential political shifts, such as a new Trump presidency, introduces additional uncertainty. However, our past experience during Trump’s initial term has equipped us with effective strategies to navigate such challenges by focusing on robust management teams capable of outperforming in turbulent conditions.
In China, the ongoing deleveraging in the real estate sector remains a headwind. Yet, the entrepreneurial spirit and adaptability of the Chinese economy should not be underestimated. Historical resilience suggests potential for recovery and growth despite these challenges. This is why foreign investment in China has been so robust, despite varying geopolitical climates.
Our investment strategy includes diversifying revenue sources, mirroring our approach to portfolio diversification. This year, exploratory visits to Taiwan, Japan, and South Korea have highlighted compelling investment opportunities within the AI and technology sectors, suitable for inclusion in our portfolio based on stringent selection criteria. Personal insights gained from visiting over 20 companies in Japan as early as November 2022 suggest emerging shifts in wage inflation and management practices, offering a strategic advantage in forecasting market movements and positioning our investments effectively. Currently, our portfolio trades at a forward P/E of 12.5x, underpinned by a conservative estimate of 20% long-term growth. This valuation not only reflects the high potential of our selected equities but also positions us well to capitalize on the anticipated market corrections and growth trajectories in these dynamic regions. Our focus remains steadfast on leveraging deep market knowledge and a disciplined investment approach to deliver robust returns for our clients.
- Investment Strategy: We maintained focus on sectors less impacted by current market challenges, particularly those not directly affected by broader economic pressures in China. We anticipate these sectors, especially logistics and green energy buildings, to benefit significantly from ongoing e-commerce growth and increased environmental consciousness.
- Forward-Looking Strategy: We aim to expand ESR’s AUM, especially in sectors driven by enduring trends such as e-commerce and sustainability, expecting significant asset sales and value realization in the latter half of 2024.
Outlook
Emerging markets (EM) continue to represent a significant mispricing opportunity amidst global uncertainties, including geopolitical tensions and a prevailing preference for USD assets and large-cap stocks. Notably, the so-called magnificent seven, which derive over half their revenue internationally, underscore the global nature of these investments. The valuation gap between emerging and developed markets (DM) is striking, with EM trading at a price-to-earnings (P/E) ratio of 12x, contrasted with 18.9x for DM and 21.7x for the US. Despite the challenges, particularly in China, overlooking the potential in Asia means missing out on compelling, structural growth stories likely to yield considerable returns. The current outflows from EM, driven by skeptical investors, present a unique entry point. Election outcomes may initially increase market volatility, but leadership clarity could stimulate significant capital inflows, enhancing returns across these markets.
The possibility of increased tariffs under potential political shifts, such as a new Trump presidency, introduces additional uncertainty. However, our past experience during Trump’s initial term has equipped us with effective strategies to navigate such challenges by focusing on robust management teams capable of outperforming in turbulent conditions.
In China, the ongoing deleveraging in the real estate sector remains a headwind. Yet, the entrepreneurial spirit and adaptability of the Chinese economy should not be underestimated. Historical resilience suggests potential for recovery and growth despite these challenges. This is why foreign investment in China has been so robust, despite varying geopolitical climates.
Our investment strategy includes diversifying revenue sources, mirroring our approach to portfolio diversification. This year, exploratory visits to Taiwan, Japan, and South Korea have highlighted compelling investment opportunities within the AI and technology sectors, suitable for inclusion in our portfolio based on stringent selection criteria. Personal insights gained from visiting over 20 companies in Japan as early as November 2022 suggest emerging shifts in wage inflation and management practices, offering a strategic advantage in forecasting market movements and positioning our investments effectively. Currently, our portfolio trades at a forward P/E of 12.5x, underpinned by a conservative estimate of 20% long-term growth. This valuation not only reflects the high potential of our selected equities but also positions us well to capitalize on the anticipated market corrections and growth trajectories in these dynamic regions. Our focus remains steadfast on leveraging deep market knowledge and a disciplined investment approach to deliver robust returns for our clients.
U.S. Small-Mid Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom U.S. Small-Mid Cap Composite (in U.S. dollars), compared to the Russell 2500 Small Cap Index (as at March 31, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : September 30, 2017
Portfolio Positioning
The first quarter of 2024 marked a dynamic period for global markets, with significant movements across various indices and sectors:
Large Cap stocks led performance, with the S&P 500 achieving a 10.6% return and reaching a new all-time high. Mid-Cap and Small Cap stocks also posted gains but lagged behind, with the Russell 2500 and Russell 2000 returning 6.9% and 5.2% respectively. Notably, Japan experienced a significant surge, with the Nikkei Index up 21.4%, highlighting its remarkable growth over the past five years.
Real Estate and Communication Services sectors underperformed, with particularly negative returns impacting stocks in these areas due to reduced spending and competitive pressures from new entrants like Starlink. Conversely, sectors such as Industrials benefited from a more positive economic outlook, particularly due to rising interest in AI and cryptocurrencies.
The quarter’s narrow market was driven by the thematic prominence of AI and crypto related stocks. Super Micro Computer (SMCI) and MicroStrategy (MSTR), which saw substantial gains, significantly influenced index performance due to their high market caps. This is quite unusual in such a diversified index as the Russell 2500.
The U.S. economy displayed resilience, adding 303k jobs in March and showing a decline in the unemployment rate to 3.8%. Increased job participation and strong growth across various sectors suggest sustained economic momentum, lessening the immediate risk of recession.
Shifts in Federal Reserve expectations suggest that rate cuts anticipated earlier might be delayed, with potential adjustments now expected around September. This adjustment is in response to sustained economic growth rather than inflation concerns, indicating a move towards normalization.
Despite not keeping pace with the index due to the outsized impact of specific high-growth stocks, our portfolio remains well-positioned to benefit from broad market trends. The focus remains on high-quality investments with sustainable growth prospects rather than speculative plays, which align with our long-term strategy.
We ended the quarter with 42 stocks in the portfolio. Over the last three years, the portfolio has consistently owned between 40 and 42 positions at the end of each quarter, and we expect that to continue. The active weight of the portfolio was 96.6%, reflecting a highly diversified index and, historically, the portfolio sits between 95% and 98%. Our top 10 securities are 29.1% of the total portfolio weight with the top 20 representing 54.8%. At year end, our top 10 positions were 28.5% and the top 20 were 53.45%, indicating that our concentration has not materially changed.
Overall, while Q1 presented challenges, particularly with the extraordinary rises in specific AI and crypto-related stocks, our portfolio strategy continues to prioritize diversification and prudent risk management to capitalize on genuine growth opportunities and navigate market volatilities effectively.
Portfolio Changes
Our portfolio adjustments this quarter were strategically positioned to capitalize on sector strengths and adjust for market shifts:
Added Two New Stocks:
- Tempur Pedic (TPX): Recognizing the upward inflection potential in the bedding market, we initiated a position in TPX. This aligns with our anticipation of a recovery in consumer spending linked to housing. TPX’s market leadership and international growth potential, alongside the strategic acquisition of Mattress Firm, present a compelling growth narrative.
- Five9 (FIVN): We invested in FIVN due to its robust position in the cloud-based contact centre market. With only 20% of contact centres currently cloud-based, the growth runway is extensive. Five9’s strong retention rates and innovative AI modules position it well for upward trajectory in enterprise solutions.
Exited Two Positions:
- Gentherm (THRM) and IPG Photonics (IPG) were both divested from our portfolio. THRM was sold following a strategic reevaluation of its growth prospects amidst industry changes. IPG’s sale was due to stagnant top-line growth and decreasing profitability as the company transitions its business focus.
Sector Allocation:
- We maintained significant positions in Consumer Discretionary, Financials, IT, Health Care, and Industrials, reflecting our confidence in these sectors’ continued resilience and growth potential.
- We continued non-exposure to Energy, Materials, or Real Estate, aligning with our strategic assessment of underperformance in these sectors.
Significant Stock Movements:
- Installed Building Products (IBP): Following exceptional performance, profits were taken to manage the valuation recalibration. The stock’s rapid price increase necessitated adjustments to maintain balanced exposure.
- Pennant (PNTG): Recognized for its consistent performance and growth prospects, especially in the Health and Hospice sectors. Despite its low liquidity, we took profits, acknowledging its valuation stretch.
Management Moves:
- We continued monitoring of market conditions and sector performances to adjust our holdings accordingly. The focus was on high-quality stocks with robust fundamentals and growth potential.
- We adjusted positions based on performance metrics and strategic growth expectations, ensuring our portfolio aligns with both current market conditions and long-term investment objectives.
These portfolio adjustments reflect our proactive strategy of capitalizing on market opportunities and addressing potential risks to position the portfolio optimally for continued growth and performance resilience.
Outlook
With an increasingly optimistic outlook on economic growth, we are confident that the U.S. will sidestep a recession in 2024, and we anticipate that overall market returns will surpass the average.
In recent years, large-cap stocks have dominated in a climate riddled with economic uncertainties. However, as these economic uncertainties begin to dissipate and the Federal Reserve’s influence on the market starts to wane, we believe the stage is set for an exceptional performance from small and small-mid cap stocks.
This shift heralds a promising environment for these segments, which are poised to capitalize on a more stable and growth-oriented economic landscape.
- Five9 (FIVN): We invested in FIVN due to its robust position in the cloud-based contact centre market. With only 20% of contact centres currently cloud-based, the growth runway is extensive. Five9’s strong retention rates and innovative AI modules position it well for upward trajectory in enterprise solutions.
Exited Two Positions:
- Gentherm (THRM) and IPG Photonics (IPG) were both divested from our portfolio. THRM was sold following a strategic reevaluation of its growth prospects amidst industry changes. IPG’s sale was due to stagnant top-line growth and decreasing profitability as the company transitions its business focus.
Sector Allocation:
- We maintained significant positions in Consumer Discretionary, Financials, IT, Health Care, and Industrials, reflecting our confidence in these sectors’ continued resilience and growth potential.
- We continued non-exposure to Energy, Materials, or Real Estate, aligning with our strategic assessment of underperformance in these sectors.
Significant Stock Movements:
- Installed Building Products (IBP): Following exceptional performance, profits were taken to manage the valuation recalibration. The stock’s rapid price increase necessitated adjustments to maintain balanced exposure.
- Pennant (PNTG): Recognized for its consistent performance and growth prospects, especially in the Health and Hospice sectors. Despite its low liquidity, we took profits, acknowledging its valuation stretch.
Management Moves:
- We continued monitoring of market conditions and sector performances to adjust our holdings accordingly. The focus was on high-quality stocks with robust fundamentals and growth potential.
- We adjusted positions based on performance metrics and strategic growth expectations, ensuring our portfolio aligns with both current market conditions and long-term investment objectives.
These portfolio adjustments reflect our proactive strategy of capitalizing on market opportunities and addressing potential risks to position the portfolio optimally for continued growth and performance resilience.
Outlook
With an increasingly optimistic outlook on economic growth, we are confident that the U.S. will sidestep a recession in 2024, and we anticipate that overall market returns will surpass the average.
In recent years, large-cap stocks have dominated in a climate riddled with economic uncertainties. However, as these economic uncertainties begin to dissipate and the Federal Reserve’s influence on the market starts to wane, we believe the stage is set for an exceptional performance from small and small-mid cap stocks.
This shift heralds a promising environment for these segments, which are poised to capitalize on a more stable and growth-oriented economic landscape.
Global Small Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom Global Small Cap Fund, compared to the MSCI ACWI Small Cap Index in CAD (as at March 31, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : July 31, 2022
Portfolio Positioning
After a robust rally in Q4, the portfolio took a breather during this earnings season. Results for 2023 surpassed expectations, and the outlook for 2024 is modestly positive, emphasizing a stronger second half. Management teams cited several factors: the end of the destocking cycle across industries, green shoots for organic demand growth from a more resilient economy, pricing increases from 2023 affecting the full year, normalizing supply chains, improving input cost inflation, and lower interest rates as companies prioritize debt repayment in capital allocations. These factors suggest corporate earnings have stabilized with potential for expansion later this year.
In terms of performance, we saw strength in our consumer discretionary holdings as the outlook for the year brightens, particularly in the U.S. Conversely, the portfolio underperformed relative to the index, primarily due to our lack of exposure to Energy, Cryptocurrency, and Gen AI-related stocks. Stock selection also contributed to underperformance, notably Iridium, which declined based on weak 2024 guidance and market share losses to Starlink—a concern we’re monitoring closely. On a positive note, MDA, a leader in the global space industry focused on robotics, satellite systems and geointelligence, emerged as a top performer with strong results and several significant contract wins.
Overall, we remain pleased with the current portfolio positioning and see tremendous valuation disconnects for small-cap stocks globally, especially in Europe. A notable event was Marlowe selling a segment representing approximately 40% of its EBITDA for over 120% of its total market capitalization, highlighting the undervaluation in the region. If public markets don’t recognize these assets, private market investors likely will.
Significant contributors to performance in Q1 2024:
- MDA Ltd (24.42%)
- Marlowe (19.83%)
- Armstrong World Industries (26.63%)
Stocks that detracted from performance in Q1 2024:
- Iridium (-36.14%)
- Keywords Studios (-22.37%)
- Datagroup (-22.22%)
Portfolio Changes
- This quarter, we added a new name: Five9, a leading provider of cloud-based contact center software. Founded over 20 years ago, Five9 pioneered the CCaaS industry and is now a top enterprise player with over 3,000 customers generating nearly $1B in FY23 revenue. The company’s high retention rate and the low market penetration of cloud services suggest significant growth potential.
- We exited several positions, including Grand Canyon Education, Gentherm and Geely, replacing them with more promising opportunities.
- We also moved away from “Big Technology” due to repeated misses against our investment thesis.
Outlook
From our recent trip to New York, Miami, Tokyo and London, we encountered a mosaic of opinions from corporate executives that are more positive. However, two major overhangs linger in everyone’s mind: 1) Fed decisions and 2) U.S. elections. As sentiment on rates pivots on a weekly basis, we are taking a long-term view that the direction of travel for rates is neutral to positive for our portfolio companies, both in terms of earnings growth and multiple expansion.
The U.S. election has traditionally been a positive catalyst for the market, especially if there is a Republican presidency. Interestingly, we are receiving commentary from U.S. executives that a Trump presidency would be a return to normal for U.S. corporations.
In Europe, our conversations lead us to believe that the worst is behind us. In the U.K., the election could reset the sentiments for both the consumer and the business community, especially in the real estate sector. In Germany, the Mittelstand is slowly but surely adapting to the new economic reality of higher input costs, and the weaker demand, especially from China, seems to have finally found a floor. Overall, it appears that excess inventory and supply chain disruptions that plagued European companies are mostly behind them.
In Asia, we are observing a bottoming of sentiment in China, as the government’s refusal to bail out the real estate sector is finally settling into the mindset of investors. Moreover, we observed a determination by the central government to focus on sustainable growth from the service and technology sector. We believe the increasing self-reliance of the Chinese economy will have an outsized impact on export-driven countries such as Taiwan, Japan and Germany for years to come. In Japan, we are seeing meaningful and coordinated efforts by the government, the Bank of Japan and market participants to increase the vitality of Japanese companies. We believe the changes are real, prompting us to increasingly search for opportunities in that market.
Finally, we continue to see opportunities for our portfolio stocks in the years to come and believe that these names are well-positioned for the future.
ESG Highlights
Five9 is a software company with a minimal carbon footprint outside of the office space leased in LEED-certified multi-tenant buildings it occupies. On the social front, Five9 has been recognized among the best companies to work for in various surveys and rankings, such as Fortune’s Best Workplaces in Technology. This is also supported by Five9’s employee engagement scores >90, and further evidenced by the company’s low annual employee turnover, which averaged only 8% over the past three years. As for governance, we are encouraged by the management team’s solid track record since the 2014 IPO and believe the company is well-managed—the team has a prudent history of capital allocation and generally provides conservative guidance. The board of directors, while being classified, has made great strategic decisions over the years and has a history of attractive shareholder value creation.
Charles River Laboratories International announced the publication of its 2023 Corporate Citizenship Report. Among the key highlights, the company became a signatory to the United Nations Global Compact (UNGC). Additionally, this report demonstrates the company’s commitment to equity by advancing women in leadership, with women representing 53% of total leadership in 2023, and the composition of women at the Executive Leadership level (VP+) increasing to 42% in 2023. The company reduced Scope 1 and 2 global greenhouse gas (GHG) emissions by 37% over the last five years, targeting a 50% reduction by 2030. It achieved 92% renewable electricity usage globally, working toward the deployment of 100% renewable electricity across operations by 2030.
The U.S. election has traditionally been a positive catalyst for the market, especially if there is a Republican presidency. Interestingly, we are receiving commentary from U.S. executives that a Trump presidency would be a return to normal for U.S. corporations.
In Europe, our conversations lead us to believe that the worst is behind us. In the U.K., the election could reset the sentiments for both the consumer and the business community, especially in the real estate sector. In Germany, the Mittelstand is slowly but surely adapting to the new economic reality of higher input costs, and the weaker demand, especially from China, seems to have finally found a floor. Overall, it appears that excess inventory and supply chain disruptions that plagued European companies are mostly behind them.
In Asia, we are observing a bottoming of sentiment in China, as the government’s refusal to bail out the real estate sector is finally settling into the mindset of investors. Moreover, we observed a determination by the central government to focus on sustainable growth from the service and technology sector. We believe the increasing self-reliance of the Chinese economy will have an outsized impact on export-driven countries such as Taiwan, Japan and Germany for years to come. In Japan, we are seeing meaningful and coordinated efforts by the government, the Bank of Japan and market participants to increase the vitality of Japanese companies. We believe the changes are real, prompting us to increasingly search for opportunities in that market.
Finally, we continue to see opportunities for our portfolio stocks in the years to come and believe that these names are well-positioned for the future.
ESG Highlights
Five9 is a software company with a minimal carbon footprint outside of the office space leased in LEED-certified multi-tenant buildings it occupies. On the social front, Five9 has been recognized among the best companies to work for in various surveys and rankings, such as Fortune’s Best Workplaces in Technology. This is also supported by Five9’s employee engagement scores >90, and further evidenced by the company’s low annual employee turnover, which averaged only 8% over the past three years. As for governance, we are encouraged by the management team’s solid track record since the 2014 IPO and believe the company is well-managed—the team has a prudent history of capital allocation and generally provides conservative guidance. The board of directors, while being classified, has made great strategic decisions over the years and has a history of attractive shareholder value creation.
Charles River Laboratories International announced the publication of its 2023 Corporate Citizenship Report. Among the key highlights, the company became a signatory to the United Nations Global Compact (UNGC). Additionally, this report demonstrates the company’s commitment to equity by advancing women in leadership, with women representing 53% of total leadership in 2023, and the composition of women at the Executive Leadership level (VP+) increasing to 42% in 2023. The company reduced Scope 1 and 2 global greenhouse gas (GHG) emissions by 37% over the last five years, targeting a 50% reduction by 2030. It achieved 92% renewable electricity usage globally, working toward the deployment of 100% renewable electricity across operations by 2030.
